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David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures. Also, though David runs Aleph Investments, LLC, this blog is not a part of that business. This blog exists to educate investors, and give something back. It is not intended as advertisement for Aleph Investments; David is not soliciting business through it. When David, or a client of David's has an interest in a security mentioned, full disclosure will be given, as has been past practice for all that David does on the web. Disclosure is the breakfast of champions. Additionally, David may occasionally write about accounting, actuarial, insurance, and tax topics, but nothing written here, at RealMoney, or anywhere else is meant to be formal "advice" in those areas. Consult a reputable professional in those areas to get personal, tailored advice that meets the specialized needs that David can have no knowledge of.

Bailouts Must Be Odious

There has been a significant shift in bailout psychology over the last week or two. The grand shift has been to make the cost of receiving money from the US government smaller, which gets “banks” to line up for cheap money, and non-banks like CIT and American Express to become banks. Insurers with Thrift arms can be “banks” as well. The hurdle for help is low.

This is the wrong philosophy. Bailouts have to be the best of a bunch of bad solutions, rather than something financial companies like. Common and Preferred Equity need to get whacked hard, and subordinated debt needs to take a haircut.

The present situation has the Treasury coming back to Congress for the second $350 billion quite rapidly, with little accountability for what they have done already. How can we tell that what the Treasury has done is right? How can we tell that it is fair? Answer: we can’t.

In giving and forcing money into healthy institutions, the Treasury has wasted money, in my opinion. Far better to give it to marginal institutions that need a little to get by in exchange for a large stake in the institution. But what they have done so far resembles giving aid to the largest politically connected firms, whether they need it or not.

Going back to Walter Bagehot, Central Banks should lend without limit at a penalty rate during a crisis. That rate should hurt, but it is better than no access to credit. To do otherwise is to shortchange taxpayers, and place the value of the Dollar at risk. That is what we are doing now.

Consider these graphs:

http:/www/alephblog.com/wp-content/uploads/2008/11/

Or, the oversimplified version:

The Federal Reserve was once a simple institution. Bloated with too many people for the task at hand, but simple all the same. But now, the Fed no longer controls its destiny. What high-quality securities that Fed holds belong to the US Treasury. And, if you look at the top graph, you will see a gap in the Northeast corner. That represents the degree that the Fed is short high quality Treasury assets. Not pretty. In a real crisis, where the Fed would face a call on cash, the result would either be inflation or severe recession.

Our government is rhyming with what it did during the Great Depression; they aren’t finding ways to reduce overall debt levels. They are moving deck chairs around on the Titanic. Our economy will not be healthy until we reduce debt relative to GDP. That’s not on the agenda now, which means we might imitate Japan for the next few decades, assuming our entitlements crisis doesn’t do us in.

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About David Merkel

David J. Merkel, CFA, FSA, is a leading commentator at the excellent investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited David to write for the site, and write he does — on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, and more. His specialty is looking at the interlinkages in the markets in order to understand individual markets better.
David is also presently a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. He also manages the internal profit sharing and charitable endowment monies of the firm.
Prior to joining Hovde in 2003, Merkel managed corporate bonds for Dwight Asset Management. In 1998, he joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life.
His background as a life actuary has given David a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that David will deal with in this blog.
Merkel holds bachelor’s and master’s degrees from Johns Hopkins University. In his spare time, he takes care of his eight children with his wonderful wife Ruth. View all posts by David Merkel →